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COVID-19: Considerations for tenants

COVID-19: Considerations for tenants

Overview

Many commercial tenants urgently need to reduce their rent payments and other payments due under their leases. The Coronavirus Act 2020 (the "CA") which protects commercial tenants from eviction for non-payment of rent has given tenants some security. However, it does not remove their obligation to pay rent (and any interest that would accrue on late payment of rent) and is presently of only three months' duration, expiring on 30 June 2020. The Government will need to consider whether to extend this for longer and how repayments of arrears accruing in this period will be made.

Many tenants have already approached their landlords to ask for assistance in mitigating their financial situations.  They have requested rent holidays, rent reductions, and monthly as opposed to quarterly rent payment schedules.  Some tenants are also seeking longer term variations of their leases and are proposing timetables for repayment of arrears. Tenants have also threatened to decline to pay rent or certain items of a service charge. Tenants wishing to reduce liabilities will be considering whether they can exit their leases altogether. 

Some tenants will be close to insolvency if they cannot reduce their liabilities.  For them in particular, it may be difficult to justify giving landlords a preference by paying rent quarterly in advance for premises that are shut or barely trading when other business payments may only be due in arrear or on a monthly basis. The directors of such tenants will need to be careful not to infringe insolvency legislation.

We have seen several different types of request from tenants in respect of payments under leases. We provide comments on these below. We hope this may help you to decide what, if anything, to do in order to mitigate rent and other payments payable under your leases. Please be aware that every situation is different and you must also consider the full terms of your lease and any other information you have before deciding what to do. We are happy to discuss this with you and to assist you in reviewing specific leases.

This note focuses primarily on the considerations that are likely to arise in landlord and tenant negotiations, during the COVID-19 crisis.  Tenants will also be concerned about any exposure they have to previous landlords under authorised guarantee agreements, other forms of guarantee and, less commonly, under "Old Leases". If you have any concerns around residual and contingent liabilities in respect of leasehold interests you have assigned, we would be happy to discuss this further with you.

The position is likely to change as a result of further legislation which we anticipate will be introduced to deal with issues for landlords and tenants arising from Covid-19. Once the Corporate Insolvency and Governance Bill is brought into force, we expect there to be limitations on landlords' ability to exercise its rights to take certain enforcement action against tenants.  We will update this note regularly to reflect such changes.

What can you ask for?

May we pay less rent?

We have seen requests from tenants to pay less rent for a fixed period of 3 or 4 months, for the period during which the Covid-19 virus affects trade and for the remainder of a lease. Sometimes these requests are coupled with a proposal to pay the arrears caused by the reduced rent at a later date, which will increase the likelihood of such a request being accepted promptly.   

Leases, except where rent is entirely calculated by turnover, do not contain provisions allowing reductions in rent. This may change in the future. In one recent Landlord and Tenant 1954 Act lease renewal claim, the court imposed an upward or downward rent review into a renewal lease. However, at present, rent can only be reduced or delayed by agreement between a landlord and a tenant.

If your landlord is prepared to negotiate a change to your rent payment obligations under the terms of your lease, this arrangement should be documented. If it is not, there is a risk of future dispute. For example, if a clear record is not made of the period of rent suspension or reduction, this may very well be disputed once landlords see the Government lifting restrictions and once they think economic conditions are improving.  

A change in rent payment terms can best be recorded in a side letter. This is preferable to a deed of variation of a lease, as a variation is more time consuming to negotiate. The side letter should contain:

  • the new rental payment terms including the terms, if any, of repayment of the accrued arrears;

  • the length of time for which these new arrangements will last and the situations when the landlord can revoke the concession;

  • a statement that the other lease terms remain unaffected by the concession and that the letter will be disregarded on rent review;

  • agreement as to what happens when either party assigns their interest;

  • confidentiality provisions; and

  • the agreement of any guarantor (including guarantors under AGAs) to its terms.

May we suspend rent payments for a period?

Some landlords, such as Network Rail, have agreed to waive their tenants' March quarter rents. Others such as the City of London Corporation have agreed to suspend rent payments. If your landlord is willing to waive or suspend payment of rent for a limited period, the terms of this agreement should be recorded. The landlord's ability to take action for reduced or non-payment of rents should be suspended during this period. Recent legislation protects commercial tenants from forfeiture for non-payment of rent before the end of June. The Government has announced that landlords will also be restricted from using commercial rent arrears recovery, statutory demands and winding up petitions as tools to get tenants to pay rent before the end of June. Despite this, recording the terms of any concession in writing should lessen the risk of dispute later.

Can we settle how much rent we pay without asking the landlord?

You are not entitled to reduce the rent you pay under your lease without your landlord's agreement. Following the 25 March quarter day some tenants have paid a single month's rent rather than a full quarter's. If a landlord accepts one month's rent it will not lose the right to recover the additional two month's rent as a debt if they remain unpaid.  Because of this, agreeing to pay a third of the quarterly rent rather than simply paying a month's rent will give you greater certainty that your landlord will not take action immediately.

The risk in unilaterally paying a single month's rent is that, subject to the terms of your lease, a landlord can still take action for the unpaid rent.

The Government has suspended landlords' ability to forfeit for arrears of rent. Claims for possession as a result of forfeiture for arrears that have already begun will be suspended and existing possession orders will not be enforced until after 30 June at the earliest.

The Government has now announced further measures to protect tenants. It is not yet clear whether these will apply to all commercial tenants or be targeted at the most seriously affected retail, hospitality and leisure tenants. The announced measures relate to landlords' use of Commercial Rent Arrears Recovery ("CRAR"), statutory demands and winding up petitions to force tenants to pay rent.

CRAR enables a landlord to take a tenant's goods from a premises as security for unpaid rent. To do this a landlord must serve a notice 7 clear working days before it, through an enforcement agent, attempts to enter premises to take control of goods.  An enforcement agent is only entitled to enter premises between 6.00 – 21.00 if they are open except if a tenant has deliberately removed goods to avoid CRAR. In that case the enforcement agent may be able to get a warrant from court to break in. Commonly, rather than removing goods, a landlord will seek to enter into a controlled goods agreement that allows it to come back and take possession later if the arrears of rent are not paid. 

In the existing circumstances it is likely that very few, if any, landlords will seek to exercise CRAR. This cannot be done if premises are closed, it requires coordination of a group of enforcement agents, which may be difficult, and there is unlikely to be any market for most goods that will be removed. In addition the changes to legislation announced on 23 April increase the amount of rent that must be owing before a landlord can start CRAR from 7 days to 90 days. This completely covers rent arrears for the March quarter of 2020.

The proposed legislation will also prevent landlords asserting that a tenant is insolvent for arrears of rent through a statutory demand and from applying to court for the insolvency of a tenant because of arrears of rent.  The details of how this proposed legislation will work is not yet clear.

We are not going to pay elements of the service charge that are Covid-19 related

Where a landlord of multi-let premises has incurred costs in connection with its response to Covid-19 which are outside its usual service charge expenditure, some tenants are trying to argue that such costs are for the landlord to pay, or should be recovered under its insurance policies, rather than being passed on to tenants via the service charge.  Whether or not this is a good argument will depend on the drafting of the service charge provisions in a lease. Most leases will allow recovery of costs incurred by a landlord in relation to compliance with statute, regulations, health and safety measures, safety and security and the well-being of tenants.

Tenants should, where possible, exercise their rights to review service charge budgets and accounts to satisfy themselves that the costs of services incurred are reasonable in the current circumstances.  Whilst landlords will have many on-going service charge costs that cannot be easily suspended, tenants should enquire whether, for example, staff providing services could be furloughed under the Coronavirus Job Retention Scheme or if other services could be temporarily withdrawn.

Can we change the terms of the lease permanently because we expect difficult trading conditions?

A tenant is not entitled to seek permanent variation of a lease without the landlord's agreement.  If a tenant tried to argue that because of the change in conditions it should be entitled to change the lease terms, a court would be likely to say that the changing conditions were a risk a tenant accepts when it takes a lease.  Some forward-thinking landlords may be willing to vary leases for the term but we have yet to see any landlord agree to this.

Can we terminate our lease?

If you would like to terminate your lease and a landlord would like to recover premises, now is likely to be an opportunity to do so. This is more likely to be attractive for a landlord if it already has plans for development or works to the building. We cover this in section 3 below.

For tenants who have served break notices and are expecting their leases to terminate as a result during the lockdown period, it is very important to check the terms of the break in their lease. These may require putting the premises back into a particular condition such as by removing alterations and they will almost certainly require the delivery up of premises with vacant possession. Each lease is different and tenants must consider what their break clause requires. As a general point, it is still possible to employ contractors to remove possessions from properties and the courts are unlikely to accept that Covid-19 provides grounds for a tenant to ignore the conditions of a break. Please contact us if you need advice on a lease break or break notice.

Arguments tenants may use to avoid rent payment or terminate a lease

A commercial tenant is unlikely to be able to argue successfully in court that its lease permits it unilaterally to withhold the rent. It may be able to counterclaim for an amount equivalent to the rent paid under a lease if it is unable to use the premises.

Most modern commercial leases only allow for a rent cesser on the occurrence of an insured risk. These are usually fairly narrowly drawn. They usually cover damage to buildings and property rather than the adverse financial effect of an epidemic.  Commercial leases often also contain provisions which explicitly prevent tenants from withholding or off-setting rent or other payments.

If a landlord will not agree suspension of rent then you could argue that:

Breach of Quiet Enjoyment and Derogation from Grant

The landlord has breached your quiet enjoyment of the premises or derogated from grant (for instance if the landlord has shut the premises or closed common parts for deep cleaning) and that you are therefore entitled to compensation equivalent to all the rent and any other charges.  You may also be able to claim for other losses arising. Such an argument can be based on the fact that the landlord's acts have made the premises unfit or unsuitable for the purpose for which you took them. If the premises are closed without your agreement, you would have a reasonable chance of succeeding with this argument in court.

Forfeiture

Section 82 of the CA prevents landlords from forfeiting a commercial lease falling within Part 2 of the Landlord and Tenant Act 1954 ("Pt2 LTA 1954") for non-payment of rent until 30 June 2020. The Ministry for Housing, Communities and Local Government ("MHCLG") has explained that this is intended to cover all commercial leases, so not just those falling within Pt2 LTA 1954. It has also explained that rent means any payment due from a landlord to a tenant under a lease. This would include service charges. If your landlord does close the premises without your agreement and prevents you having access, you could assert that the landlord has illegally forfeited the lease. If you want to terminate your lease, you could choose to accept this by telling the landlord that although forfeiture is illegal you will accept this and you will not be seeking relief from forfeiture. In this case it would be difficult for a landlord to maintain it had not forfeited the lease even if that was not its intention.

Force Majeure

Covid-19 is a force majeure that relieves a tenant of having to pay rent. This argument is unlikely to succeed except if your lease contains specific reference to force majeure which covers the present situation. Most leases do not.

Frustration 

The lease has been frustrated because you have not been able to use the premises. This is unlikely to be a successful argument in court except if the remainder of the term is short and expires before you are able to return to the premises.  The Government's requirement for businesses to close premises may  strengthen this argument.  In most cases a temporary inability to use premises will not amount to frustration of a lease.

Other considerations

You should consider whether you have insurance that may provide any cover in relation to trading losses or lease costs. You should also consider your financial position and whether there are any risks in continuing to trade and pay rent.

Insurance

Landlord's insurance policies will almost certainly not protect a tenant against the closure of its premises. These polices may protect the landlord against the costs of this. If you have interruption of business insurance or another policy that gives some protection for loss of trade, this may help cover some of your losses and costs.

Risks of continuing to trade

Directors have a duty not to trade once they conclude or should have concluded that their company cannot avoid an insolvent liquidation or administration. They must minimise loss to the company's creditors. This duty can be enforced directly against a director by means of disqualification from acting as a director for up to 15 years, by fines and by a requirement to repay losses resulting from continued trading when a director should have concluded the inevitability of an insolvent liquidation or administration. The Government has proposed legislation to suspend directors' liability for wrongful trading. This is likely to protect directors continuing to run companies that at present could not avoid insolvent liquidation or administration but it does not remove their duties to their shareholders.  We can provide further advice on this if required.

Financial defaults under loan agreements

You should check if a failure to pay rents may amount to an event of default under any loan agreements. If so, your lender should be informed before you fail to pay any rent.

What is a landlord entitled to do if it does not want to reduce or suspend rent payments?

A landlord is not obliged to accept a request for rent reduction or suspension. It may not be able to enforce the obligation to pay rent if it has closed premises or made them impossible to use.  It cannot forfeit before 30 June 2020 for arrears.

Rent Deposit

A landlord faced with unpaid rent may be able to avail itself of any rent deposit. It could attempt to require topping up of that deposit. If premises are closed or incapable of beneficial use, a court may say that the deposit has been used as a result of the landlord's breach of the lease and refuse to enforce the terms of a rent deposit deed.

Guarantee

A guarantee will be enforceable to the extent that the breach of covenant the tenant has committed is properly enforceable against the tenant. The guarantor usually has the same defences to a claim by a landlord as the tenant has. Subject to this and the validity of the guarantee, landlords can continue to recover under guarantees.

Court claims for payment of rent

If a landlord shuts premises without your agreement and then brings court proceedings to recover unpaid rent, you could counterclaim for losses resulting from the closure and a court would almost certainly award you damages amounting to the rent that they would have paid, other charges under the lease and losses arising from any loss of business. This would more than set off the amount owing for rent and other charges.

Threats to wind up a tenant

As the March 2020 quarter has progressed, there has been an increased use by landlords of statutory demands for rent arrears. If a statutory demand is not paid this is prima facie evidence that a tenant is insolvent. Statutory demands do not need to be sent to a corporate tenant before petitioning to wind it up but landlords find this a useful way of applying pressure to force payment if a tenant is not genuinely insolvent. A statutory demand may result in a breach of lending covenants or other embarrassment for a tenant as well as the risk that a landlord will proceed to petition to wind up a tenant. Similarly a winding up petition can be used to pressurise a tenant to pay rent as it must be advertised and will become public knowledge if it proceeds to a winding up hearing in court.  On 23 April 2020, the Government announced temporary measures to protect commercial tenants from landlords using statutory demands and winding up petitions to force payment of rent. This will be contained in the Corporate Insolvency and Governance Bill. 

The measures will include a temporary ban on the use of statutory demands to provide evidence of insolvency and winding up orders where a company cannot pay their bills due to coronavirus.  It is not yet known which commercial tenants will benefit from these arrangements (for example, whether it is limited to tenants in the retail, hospitality and leisure sector) or what a tenant would have to provide to evidence that it cannot pay its bills due to the epidemic. We continue to monitor this but this is likely to improve the negotiating position of tenants in requesting rent concessions and repayments plans as set out above. We have already seen tenants starting to use this in negotiations.

Forfeiture

The CA has prevented landlords from taking steps to forfeit and recover possession of premises as a result of a failure to pay rent.  MHCLG has recorded that rent in this context is any payment due from a tenant to a landlord under a commercial lease. This protects occupational tenants and probably intermediate commercial tenants although the MHCLG has not clarified this. The legislation would not be effective if a superior landlord could forfeit an intermediate lease which would have the effect of terminating an occupational sublease. This removes the risk of forfeiture for arrears for three months ending on 30 June 2020 (unless the UK Government extends the relevant period).  The Act does not exclude existing arrears from this protection and so it would seem that the arrears do not have to be arrears that accrue in the March 2020 quarter alone. 

At the moment, a landlord can still forfeit and recover possession of premises as a result of other breaches of leases, for example, failure to comply with keep open clauses, insolvency defaults or wants of repair.  The MHCLG has confirmed that it is keeping action in respect of CRAR and winding up under consideration. The CA does not change the position in respect of existing enforcement action.

Whilst tenants that go into arrears on their rent will be protected from eviction in the short term, they will need to repay the arrears in full plus accrued interest once the protection is lifted (be that 30 June 2020 or later if the UK Government extend the arrangements) to avoid facing forfeiture proceedings at that point.  For this reason, we continue to recommend that landlords and tenants enter into discussions regarding rent suspensions and repayment terms, and document what is agreed to avoid later disputes.

Keep open clauses

Leases which contain rents calculated on the basis of turnover, particularly in the retail sector, often oblige tenants to stay open for business during normal opening hours. Where footfall and has dropped significantly for tenants, tenants will be considering closing premises. 

Courts can require tenants to keep premises open.  This usually only happens where a tenant is an anchor store or has some other special significance to a landlord.  A court has discretion whether to award specific performance or damages for loss of profit as a remedy for a tenant's failure to keep premises open.  In the present circumstances with little footfall and poor trade, the balance of convenience between the landlord and the tenant is likely to persuade a court to refuse a claim by a landlord for specific performance.  Instead the court is more likely to award damages for loss. The landlord's losses where there is little footfall are likely to be small. This is particularly the case if the nature of the premises means that the tenant is required to close. The Government's instruction of 20 March to cafes, pubs, restaurants and other leisure venues to close will mean that a court will not require these to remain open in contravention of the law.

Recovering rent directly from sub-tenants

When a tenant is in arrears of rent, a landlord is permitted by section 81 of the Tribunals, Courts and Enforcement Act 2007, to serve a notice on any sub-tenant of the premises requiring it to pay rent directly to the landlord until the arrears have been cleared. While landlords may attempt to get rent arrears paid in this way, we expect that they will not be permitted to forfeit the intermediate lease if the sub-tenant does not pay. As a result the position here is similar to that of a tenant who does not pay rent. The superior landlord cannot enforce this through forfeiture at the moment.  We expect that a landlord will not be prevented from serving a statutory demand and/or issuing winding up proceedings on a sub-tenant, where section 81 applies, as a result of the temporary ban on these measures proposed by the Government discussed above.

Conclusion

If you want to try to reduce rents payable under your leases, you should approach your landlord to propose this. Most landlords do not want vacant premises and are unlikely to take action against you if you do not pay rent for the next three months at least. The protection given to tenants in respect of forfeiture and also the restriction on threats to wind a tenant up should assist with these negotiations although, as described above, it is not a perfect solution and should not be relied upon in place of formal arrangements with landlords.

Many landlords have already considered and agreed rent reductions and rent holidays with tenants. Landlords like to believe that they will eventually recover unpaid rents. It is too early to know if this is correct. The measures announced by the Government to date have focused on the financial position of tenants.  There are no current proposals for a scheme to reimburse landlords for lost rents (although there is on-going consultation in this respect).  It appears likely that landlords will be under increasing pressure as the June 2020 quarter approaches and beyond.  This will affect the ability of some landlords to agree concessions with their tenants.

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